Taxation - Income, Estate, and Gift
By Eva Stark, JD, LL.M.
Most high net worth clients or the owners of highly successful businesses are aware that estate taxes could be a potential concern; beyond that, many have no familiarity with even the most rudimentary estate tax concepts, such as the federal estate tax basic exclusion amount. This might lead to missed planning opportunities in some cases. The following list of general items to know about the federal estate tax basic exclusion amount can help clients gain a better understanding of the workings of federal estate taxes and may help them ask better questions during the planning process.
1. Individuals are generally entitled to a basic exclusion amount for federal estate tax.
The "basic exclusion amount" is the value of taxable gifts that an individual can give to any donee while alive, or to any heir after death, without triggering federal gift or estate taxes. In 2021, the basic exclusion amount is $11.7 million; it is adjusted annually for inflation.
As taxable gifts are made during an individual's lifetime, portions of this amount can be utilized to offset any gift tax due. Once the exclusion amount is exhausted, additional taxable gifts will generally trigger gift tax liability. Upon the individual's death, his or her unused exclusion amount, if any, may be used to shield transfers to heirs from estate tax. Taxable transfers at death that exceed the decedent's unused exclusion amount will generally trigger estate tax.
2. The basic exclusion amount currently includes a temporary "bonus" that will disappear at the end of 2025.
The Tax Cuts and Jobs Act of 2017 (TCJA) doubled the basic exclusion amount, from $5 million under the American Taxpayer Relief Act of 2012, to $10 million, adjusted for inflation. However, certain provisions of the TCJA were not made permanent and are scheduled to sunset on December 31, 2025.
One of the sunsetting provisions is the doubling of the basic exclusion amount. If the "bonus" $5 million (plus inflation adjustment) is not utilized before it expires, it will be lost. Note, too, that federal legislation to change this provision could be enacted prior to 2026. Clients and their advisors should consider taking advantage of this window of opportunity, if feasible, before it closes.
3. Not all gifts diminish an individual's basic exclusion amount.
An individual may gift his or her assets without tapping into or utilizing his or her basic exclusion amount in some cases. For example:
- Transfers to a spouse generally qualify for a marital deduction to gift or estate tax.
- Transfers to qualifying charities generally qualify for a charitable deduction.
- Individuals also are generally entitled to make annual exclusion gifts of $15,000 per year, per donee, in 2021 (or twice that amount if the donor splits gifts with his or her spouse). The annual gift tax exclusion is also adjusted for inflation, but only in $1,000 increments.
- Generally, payments made for qualifying educational or medical expenses on behalf of a donee paid directly to an educational institution or medical provider do not diminish the donor's annual gift tax exclusion (the $15,000) or his or her basic exclusion amount (the $11.7 million).
4. Surviving spouses may utilize their predeceased spouses' unused exclusion, but many caveats exist.
An individual may be able to utilize his or her deceased spouse's unused exclusion in certain circumstances if a "portability" election is made. A portability election may be made on an estate tax return that meets specific requirements. However, one potential concern with reliance on portability is that it is only applicable to a deceased spouse’s unused estate tax exclusion, not generation-skipping transfer tax exclusion.
Another potential concern is that a subsequent remarriage of the surviving spouse may affect the amount that may be available for the surviving spouse from the deceased spouse's unused exclusion.
For example, suppose that Bob and Linda are successful business owners with an estate valued at approximately $17 million. Bob, a reluctant planner, dies, leaving everything to Linda outright. A timely portability election is made, which would generally avail his unused exclusion to Linda.
Linda subsequently marries Jim, who is also a successful business owner. Unlike Bob, Jim engaged in significant estate planning and exhausted his basic exclusion amount when he gifted assets to his children from his first marriage.
Linda does not engage in planning to utilize any of Bob's unused exclusion. Jim subsequently dies while married to Linda.
Since the deceased spouse's unused exclusion applies with respect to the last deceased spouse (in this case, Jim, who has no unused exclusion), Linda would now be limited to her own exclusion amount for future gifts (see Treas. Reg. 20.2010-3(b)-(c)), significantly increasing her estate tax liability and diminishing the inheritance of her heirs.
5. State-level transfer tax regimes may be an additional concern.
If an individual is a resident of, or owns property in, a state with a state-level transfer tax, such taxes may apply even if the individual is not subject to federal estate taxation.
The exclusion amount to state-level estate tax varies greatly by state, as does the tax rate. Rules as to portability and the ability to make various elections also differ greatly from state to state.
Estate planning for high net worth clients and business owners who could have a taxable estate can be complex and time consuming. A basic understanding of some general estate tax principles can help clients better engage in the planning process. Clients may wish to explore with their attorneys or other advisors how the general principles presented above might apply in their particular circumstances and what planning opportunities and areas of concern they may create.
Eva Stark, JD, LL.M.,joined The Nautilus Group® in 2014 to assist with the development of estate and business plans. She also performs advanced tax research. Eva graduated summa cum laude with a BS in economics and finance from The University of Texas at Dallas. She earned her JD, with honors, from Southern Methodist University, where she served as a student attorney and chief counsel at the SMU Federal Taxpayers Clinic. She received her LL.M. in taxation from Georgetown University Law Center. Prior to joining Nautilus, Eva worked in private practice in tax controversy, business law, and litigation.